ELECTRICITY SECTOR REFORMS THREATEN PRIVATE SECTOR

UNCLAS SAN SALVADOR 001184 SIPDIS E.O. 12958: N/A TAGS: ENRG EINV ECON ES SUBJECT: ELECTRICITY SECTOR REFORMS THREATEN PRIVATE SECTOR PROFITABILITY REF: 08SANSALVADOR905 ¶1. SUMMARY. Proposed regulatory reforms in the electricity sector will introduce a cost-based pricing system with publicly bid long-term contracts, designed to promote transparency in energy costs, reduce price volatility, and foster healthy competition in the sector. While both private sector energy generator and distribution companies support the transition to a cost-based model, the generators have criticized several key elements of the reform which they believe, if not properly modified, could damage profitability and prompt companies to leave the Salvadoran market. END SUMMARY. ¶2. (SBU) The GOES plans to implement new electricity regulations in June 2010 that introduce a framework for long-term publicly bid contracts between electricity generators and distributors and establish pricing formulas for wholesale electricity. The proposed reforms will transition the sector from a marginal cost "spot market" methodology to a cost-based pricing system. Currently, electricity is sold on the spot market in marginal cost increments, where the highest price per unit purchased each hour determines the rate that all generators receive, regardless of the true cost of energy produced. The current price regime creates volatility in electricity prices and led the GOES to intervene for political reasons in the market several times to freeze electricity prices (see reftel). ¶3. (SBU) The proposed cost-based model will have two price components: a capacity payment for fixed costs and a variable payment for variable costs such as fuel. Generators will be required to calculate their capacity payment using a gas turbine model, which represents the lowest capacity cost in the industry at $6.75 per Mega-Watt Hour (MWH),but has high variable costs. The reform also calls for 50 percent of the total energy generated by private sector companies to be sold through publically bid long-term fixed contracts by 2012, with the remainder sold on the spot market and through private bilateral contracts. ¶4. (SBU) Private sector electricity generators and distributors are in general agreement that the transition to a cost-based model is a positive step and will bring El Salvador in-line with modern industry standards already in place in the majority of Central America. However, generators assert the proposal fails to capture the true costs of generation. According to Alberto Triulzi, President of Cenergica, and Carlos Polanco, Director of Commercial Development at Duke Energy, executives from the two largest private generators in the country, the primary flaw in the GOES model is that none of the generators in El Salvador utilize gas turbine technology. Triulzi said their motors cost three-times as much as a gas turbine, although their variable costs are much lower. He said the Salvadoran Electricity Regulator (SIGET) has argued that generators can compensate for the difference by increasing their variable costs. Their variable costs will be audited, however, and they are therefore unable to artificially inflate these costs to compensate for such a large difference. Triulzi and Polanco stated the use of the gas turbine model for capital costs is a thinly veiled attempt to keep energy costs low at the generators' expense. ¶5. (SBU) Triulzi and Polanco also criticized the approach to long-term contracting. They argue that contracting out only 50 percent of the demand does not provide the stability needed in order to guarantee existing investments or attract new investment. In their view, the GOES should follow the example of Guatemala and Panama where 100 percent of demand is contracted. Polanco said this factor recently led Duke Energy to decide upon building a coal-fired plant in Guatemala instead of El Salvador because banks are more willing to provide credit based on the added stability of long-term contracts. Additionally, both complained that the state-owned CEL and La Geo, which supply 60 percent of the country's electricity, are not required to participate in long-term contracts. ¶6. (SBU) Private sector groups and U.S. owned generation and distribution companies have been lobbying the Salvadoran Superintendent of Electricity Regulation (SIGET) to modify the proposal. However, generators and distributors have significant differences in opinion over the provision on long-term contracts. According to Ingrid Mendoza, Commercial Planning Manager of the distributor Delsur, long-term contracts for 100 of demand represent a huge financial risk. Mendoza said the Salvadoran law does not provide geographic exclusivity to distribution companies and permits other companies to enter into their territory and "poach" large profitable clients. Under existing law, clients in their geographic area can enter into private contracts with secondary companies who offer to provide energy at a lower cost and use their electric grid through a fee. ¶7. (SBU) On December 7, Econoff discussed the reforms with Geovanny Hernandez, the Electricity Regulation Manager at SIGET. Hernandez said the reforms were originally developed in 2005 during the Saca Administration, but at the time, the former Superintendent did not meet with the private sector and refused to consider changes to the model. Hernandez said the new Superintendent, Tomas Campos, has already held several meetings with the private sector. Hernandez said the Superintendent agrees with the argument that mandating only 50 percent of electricity demand in long-term contracts is not sufficient to guarantee new investment or to reduce price volatility, but he added that 100 percent may not be the answer. Hernandez said they are considering supporting a modification to 80 or 90 percent of demand. Hernandez also acknowledged that distribution companies face financial risks with long-term contracts and SIGET is analyzing possible solutions. ¶8. (SBU) COMMENT: The transition to a cost-based model is a positive development for the energy sector and will provide needed transparency and stability to electricity prices. The planned reforms will align El Salvador with regulation standards already in place in neighboring Central American countries, which will assist in harmonizing Central American Electrical Interconnection System (SIEPAC) regulations. The pragmatic approach taken by SIGET in negotiations with the private sector demonstrates a willingness to find mutually acceptable solutions. Long-term contracts will help attract much needed private investment in the sector. The exclusion of state-owned companies from participating in long-term contracts shows a troubling bias affecting the end users of energy and limiting economic growth. BLAU